INSTRUCTOR MANUAL
Instructor’s Manual for Principles of Finance
03/21/22 1
, Instructor’s Manual for Principles of Finance
Chapter 17
How Firms Raise Capital
Chapter Summary
A firm has to make choices about how to fund its operations on a permanent basis. This comes
down to a decision on its capital structure, specifically how much debt it should employ as
compared to equity.
Lecture Outline
17.1 The Concept of Capital Structure
Capital is composed of the two principal sources of funding for a firm’s operations:
debt: liabilities or amounts due to creditors
equity: funding provided to the company by its owners
Equity is more at risk than debt as debt has priority in getting paid back, but there is limitless
upside for an equity investment. Debt and equity holders expect to be compensated for their
capital contributions to a firm. Their funding comes with a cost to the firm.
A firm must offer competitive rates of return to both debt holders and equity holders in order
to obtain the capital it needs, so a firm’s investments should earn at least as much as the cost of
obtaining its capital.
Weights of Debt and Equity to Total Capital
In evaluating a firm’s cost of capital, the proportions of debt and equity to total capital are an
important input.
Market Value of a Firm=Market Value of Debt + Market Value of Equity
Note that market values are used and not book values. Book values represent what the
accounting financial statements carry debt and equity at, but these values are not
representative of the firm’s market values for debt and for equity.
A public firm’s debt is traded in financial markets, and its market value can be determined from
market data. Its equity will also be traded in financial markets, and its market value can also be
determined from market quotes.
Weights are calculated as follows:
Weight of Debt =Market Value of Debt /Market Value of a Firm
Weight of Equity=Market Value of Equity/ Market Value of a Firm
The result of this calculation will be in percentages of the total market value of a firm. The
percentage weight of debt plus the percentage weight of equity will be always be 100 percent.
03/21/22 2
Instructor’s Manual for Principles of Finance
03/21/22 1
, Instructor’s Manual for Principles of Finance
Chapter 17
How Firms Raise Capital
Chapter Summary
A firm has to make choices about how to fund its operations on a permanent basis. This comes
down to a decision on its capital structure, specifically how much debt it should employ as
compared to equity.
Lecture Outline
17.1 The Concept of Capital Structure
Capital is composed of the two principal sources of funding for a firm’s operations:
debt: liabilities or amounts due to creditors
equity: funding provided to the company by its owners
Equity is more at risk than debt as debt has priority in getting paid back, but there is limitless
upside for an equity investment. Debt and equity holders expect to be compensated for their
capital contributions to a firm. Their funding comes with a cost to the firm.
A firm must offer competitive rates of return to both debt holders and equity holders in order
to obtain the capital it needs, so a firm’s investments should earn at least as much as the cost of
obtaining its capital.
Weights of Debt and Equity to Total Capital
In evaluating a firm’s cost of capital, the proportions of debt and equity to total capital are an
important input.
Market Value of a Firm=Market Value of Debt + Market Value of Equity
Note that market values are used and not book values. Book values represent what the
accounting financial statements carry debt and equity at, but these values are not
representative of the firm’s market values for debt and for equity.
A public firm’s debt is traded in financial markets, and its market value can be determined from
market data. Its equity will also be traded in financial markets, and its market value can also be
determined from market quotes.
Weights are calculated as follows:
Weight of Debt =Market Value of Debt /Market Value of a Firm
Weight of Equity=Market Value of Equity/ Market Value of a Firm
The result of this calculation will be in percentages of the total market value of a firm. The
percentage weight of debt plus the percentage weight of equity will be always be 100 percent.
03/21/22 2
